Impact of the GST:

In India’s international trade in service transactions, Transportation services account for only 12 % of Total Exports, But 52.6 % of the Imports.

It is in this sector therefore India will need to be a lot more competitive if it is to manage its large and persistent trade deficit. Recent initiatives of the Indian government on port development and inland transport development are therefore steps in the right direction.

In Merchandise Trade, a less well known indicator is moderately large trade surplus contributed by the agricultural sector. Thus 2014 agricultural products were 13.5 % of the exports, but 5.9 % of Imports. How to increase this surplus is a challenge for India. But it must be met to not just improve the trade balance, but to increase India’s strategic space globally.

As agriculture sector is especially challenging in GST administration, how GST rules are structured for this sector will impact on meeting the above challenges. So these will need to be especially monitored.

Structure of Combined Union and State Government Taxation Revenue of India (Data for 2013-14)

India thus derives only 1.7 % of GDP in taxes from services contributing 53 percent of GDP (and even Services Tax was not levied till 1994), and 6.8 percent of GDP from manufacturing 9largely) contributing only 17.2 percent of GDP. As households spend greater of income on services as incomes increase, in the name of socialism, the Congress dominated governments which have been in power for most of the years since independence, have set up regressive tax system, disproportionately burdening low4er half of the Indian households.

India’s Constitution does not permit the Union Government to levy Sales Taxes on Goods, and the State governments to levy sales taxes on Services. A Constitutional Amendment Bill 2014 (122nd Amendment) will correct this anomaly, once it is passed.

Treatment of cross border transactions. In Federal countries, such as India, inter-state transactions are possible

VAT/GST may not be Self-Enforcing, but is any tax?

GST and Agriculture (agriculture is sensitive issue in India as over half of the population derives major part of livelihood from this sector, but it contributes less than one-fifth of India’s GVA).

In emerging economies, agricultural producers are outside the formal sector or do not have sufficient records for an accurate measurement of turnover.

Physical remoteness, seasonal nature (resulting in a mismatch of timing in inputs and outputs) complicate measurement & payment procedures. These result in higher administrative costs.

The sector is often a particular concern in the pursuit of wider distributional objectives. A tax on food is either borne by consumers through higher prices, or by farmers through reduced real income, or a combination of both.

Both of these options are perceived to be regressive (essentially for basic unprocessed vegetables). There is however debate in the literature as many farmers have high incomes.

Moreover, expenditure policies may be more efficient at achieving re-distributive priorities.

This suggests that agricultural products should be fully within the VAT system

Either taxed at regular rates or low rates (possibly zero)

Long-term objective in the treatment of agriculture is clear: tax agriculture as any other good, subject to the normal threshold.

But high collection costs may validate other methods

Exemption ensures that agriculture is taxed at a reduced but positive rate because of the absence of relief paid on inputs results in distortion in the production and a greater reliance on untaxed inputs.

VAT Rates in OECD countries

There is a wide range of lower rates, exemptions and special arrangements under VAT that are frequently designed for non-tax policy objectives. Uniform single rate for both the goods and the services is usually an ideal for tax neutrality, and for ease of administration and compliance. But it is not always achieved, particularly once the rate approaches 15 percent

Considerations in setting VAT Threshold

Empirical evidence suggests that a relatively small proportion of firms account for large proportion of potential VAT revenue.

More effective to concentrate resources on the largest tax payers, as the revenue to be raised from smaller firms is seen insufficient to warrant the resources required for its collection.

Despite significant variation, a useful rule of thumb is that the largest 10 percent of all firms account for 90 percent or more of all turnover.

At the margin, a 1% increase in the threshold is initially very cheap in terms of revenue foregone, but becomes much more expensive at higher levels of turnover.

If it were not for the costs of administering VAT (incurred by authorities) and complying with it (by tax payers), the best threshold would be zero. This would minimize distortions as well as maximize revenue.

It is important to recognize that administrative costs are not exogenous: the costs of coping with each taxpayers depend on design choices as the frequency of audit, the nature of audit, the complexity of the tax structure, and so on.

Experience indicates that setting too low a threshold can significantly compromise the political and administrative feasibility of a VAT.

Some countries have different thresholds by sector, but limited economic rationale for this.

Part -2 will Discuss about measuring VAT performance to assess potential for progress, Issues in taxing certain sectors (agriculture has been covered in this part), and recent developments in preparing for GST in India. (References to Part 1 and Part 2 will be provided in Part-2)

Mukul G. Asher is a Professorial Fellow, Lee Kuan Yew School of Public Policy, National University of Singapore. This article was first published in MyIndMakers on 22 April 2016.